Modern Portfolio Theory (MPT)
Optimize the portfolio as a whole, not security by security.
What is Modern Portfolio Theory (MPT)?
Markowitz's framework: for any level of risk there is a mix maximizing expected return, because combining imperfectly correlated assets lowers portfolio volatility below the weighted average of the parts. Risk is a portfolio property, not a security property.
Modern Portfolio Theory (MPT): a worked example
Adding a volatile but uncorrelated asset can lower total portfolio volatility.
More terms in Portfolio Management
Asset Allocation
How a portfolio is split across stocks, bonds, cash, and alternatives.
Rebalancing
Periodically restoring the portfolio to its target weights.
Dollar-Cost Averaging
Investing a fixed amount on a fixed schedule regardless of price.
Efficient Frontier
The set of portfolios with the best return for each level of risk.
Capital Asset Pricing Model (CAPM)
Expected return = risk-free rate + beta x market risk premium.
Efficient Market Hypothesis
Prices already reflect available information.
Compound Annual Growth Rate (CAGR)
The smoothed annual rate that gets you from start to end value.
Total Return
Price change plus income, as a single return figure.